Sunday, July 8, 2007

Yahoo just dumped Terry Sempel, its Chief Executive Officer, after it was decided that he was not the person to take Yahoo into the battle with Google. He no longer manages the day-to-day operations of Yahoo, as it has fallen on Jerry Yang, one of the original founders of Yahoo. So what is wrong with Yahoo? Why are shareholders not getting the return they deserve? After all, this is a tech stock.

Well here's my theory of what is wrong with Yahoo. Back in 1999 during the run up to the Internet bubble, Yahoo paid $4.9 billion for a company called Broadcast.com, and a few months before that they paid $ 3.2 billion for GeoCities, a web community page company.

Now wait a minute you say. That happened 8 years ago. How could that be affecting Yahoo today?

First, let's see what these companies were that Yahoo paid $8.1 billion for back in the day.

Broadcast.com was according to its final 10-Q filed on 5/17/99:

“A leading aggregator and broadcaster of streaming media programming on the Web with the network infrastructure and expertise to deliver or "stream" hundreds of live and on-demand audio and video programs over the Internet or intranets.”

Well, it sounds very YouTubish and not all that special but remember this was 1999, when most people on line were on dial up, so let’s give Yahoo the benefit of the doubt and say that this was cutting edge technology at the time. Here’s an image of its home page back in 1998.

“The Company offers a community of personal websites on the Internet within 41 themed neighborhoods. The Company's main source of revenue is from advertising, along with other revenue streams, including fee-based premium services and commerce. The Company's business is characterized by rapid technological change, new product development and evolving industry standards.”

Again it doesn’t sound like a big deal now that we have 70 million blogs on the Internet, but this was 1999, and it was the 5th most visited site on the Internet back then. Here’s an image of it in 1999:

So here is what Yahoo got for its money. In its last quarter as a public company, Broadcast.com had revenues of $10.2 million, with a loss of $3.8 million for the quarter. In its last quarter as a public company, GeoCities had revenues of $7.82 million, with a net loss of $10.2 million.

So if you annualize the last quarter for both companies, then Yahoo paid 112 times sales. The earnings multiple can’t be calculated obviously. So why am I rehashing this debacle by Yahoo? Dozens of companies overpaid for assets at the time.

The point I am trying to make here is that at the end of the day, there has to be consequences for a company that overpays for a business, ignores financials, issues shares that dilutes current shareholders and gets nothing substantial in return for what they bought. So could it be that the laggard share performance that we are seeing now is the result of the cumulative effect of that deal stupidity?

Now at the time most everyone loved the deals. Yahoo was falling behind, and needed to do something. Analysts applauded the deals. Yahoo thought it was great since they were using “funny money.” We’re not paying real cash; we’re only issuing shares.

These weren’t the only deals that Yahoo made over the years, there were dozens, and virtually every time stock was issued, Yahoo overpaid and existing shareholders were hurt.

So how does this tie into value investing? Investors should only buy into companies where management runs its business for the long term. Not companies like Yahoo that react impulsively based on newspaper headlines or when analysts whisper in their ear in between conference presentations. This is one of the oldest investment clichés out there but it is true.

So is Google the next Yahoo? It paid $1.65 billion for YouTube in October 2006, and the company issued shares despite its cash hoard. YouTube was a private company so I don’t know its financials but it is clear to everyone that the price Google paid was far in excess of its current financial value. Will Google monetize the site? Time will solve that mystery I suppose.

Let’s do an exercise and compare the comments of Yahoo in 1999 to Google in 2006. The similarity is eerie.

Google People in 2006:

“I’m confident that with this partnership we’ll have the flexibility and resources needed to pursue our goal of building the next-generation platform for serving media worldwide,” said Hurley, YouTube’s 29-year-old CEO.”

"This is just the beginning of an Internet video revolution," Schmidt said.

Yahoo People in 1999:

"We successfully completed the Broadcast.com acquisition ahead of schedule and are moving swiftly to integrate the company's audio and video programming, business services, and advertising programs into Yahoo," Yahoo president Jeff Mallett said.

There are few barriers to entry out there for user supplied video sites. In fact, there are hundreds of competitors out there with new ones starting every day. MySpace just announced they were starting up a rival site to compete with YouTube. Now none of these sites have the market share of YouTube but that didn't help Yahoo with GeoCities, which had large market share back in 1999.

I would venture to say that first mover advantage has never worked on the Internet. Does anyone remember Visicalc? It was the first commercially available spreadsheet program back in the early 1980's. Where is it now?

Just go to Google and type in the words "start your own video web site" and you will understand what I mean.

3 comments:

Price of a strategically vital metal, palladium, rallied from $145 in 2003 to almost $400 recently, this happened with global production of 7M ounces per year, and on top of that the Russians dumping 1.8M ounces per year from their strategic stockpile. With such extreme over supply palladium should be extremely bearish, but it had been very bullish for the past four years? WHY?

Many experts believe the Russian stockpile is running low today! They can NOT continue this massive dumping. Lots of investment entities saw this and positioned themselves and silently loading up physical palladium. Once the huge Russian dumping is cut off, expect palladium price immediately shot to sky high!

This speaks extremely bullish for a little known stock called SWC, the only US based palladium producer, and richest palladium mine in the world.

An explosive 20 folds gain within 4 years or shorter can be expected. That's 2000% gain!

Good post. One of my investing rules of thumb is to look at what a management does to reinvest free cash flow. Yahoo! has not done a great job, as you ably point out.

In general, serial acquirers are not usually good investments, because most acquirers overpay. Often the best acquisitions are small in-fill acquisitions that have synergies with existing businesses, and can lead to increased organic growth.

Thanks David...just look at what other companies get when they pay $1.65 billon for a business and compare it side by side in a spreadsheet with what Google got and it will be obvious as to the problem.